Reminder: The Interest Rate on Your Savings Account Doesn’t Matter

Remember when EQ Bank came out with that 3% introductory savings rate and everyone in the PF world lost their collective minds? My God, you people were more excited than 15-year old Nelson when he discovered the actual use of the internet.

The inevitable happened, of course. EQ Bank first cut the payout to 2.5%, and now down to 2%. That’s still pretty high, even beating most GICs from the big banks–but not Oaken Financial. It still goes to show that especially in the financial world, there’s no such thing as a free lunch.

The whole reason for these high-yield savings accounts is to attract capital to a bank. This money then gets lent out to people needing cash, and the bank takes the spread–minus any fixed expenses. Since an online-only bank like EQ has very little in fixed expenses, it can afford to pay out more than your local bank that has 393043829 branches across the country.

But it can’t afford to pay out 3%, especially in an era where crappy mortgage rates start with a 4. So the inevitable happened. Some money probably left at that point, but most likely stayed. The rate is still good. This was a smart move by the management of said bank.

At the end of 2015, EQ Bank had deposits of about $8.1 billion. Six months later, it had attracted $900 million of additional capital. That is a lot of money coming from Canadian retail investors.

So it’s pretty obvious there are a bunch of people out there who really care about the interest rate their bank gives them. All it took was EQ Bank getting the word out there to raise $900 million, and I’m sure money is still pouring in.

And yet, it’s just another example of Canadian savers missing the forest from the trees.

Personally, I have between 5% and 10% in cash, with a smaller percentage in a sort of emergency fund. Basically, I like to keep a little bit of money in a very easily accessible place in case I have to pay an unexpected bill. This usually isn’t more than a couple thousand dollars.

Some people want more of a cushion, so they opt for a far larger emergency fund, even though most of the time that’s a waste of money. These people are usually just too risk-adverse for their own good, but every now and again some have a good reason for this.

The teacher I know with a $10,000 emergency fund and a contract that states she can never be fired and the iron-clad pension? That’s dumb. The freelancer with a very insecure job? Sure, why not.

But since cash shouldn’t be a big part of your portfolio anyway, it really shouldn’t matter what kind of yield you get on it anyway.

An example. Say you had $1 million in assets and you have a 5% cash position. Say the other parts of your portfolio could be expected to earn about 6% annually. Your yield would be something like this:

$950,000 @ 6% = $57,000
$50,000 @ 2% = $1,000

Even if our hero only manages to get 1% or (gasp!) nothing as a yield on his cash, it really doesn’t matter very much. The interest generated from his cash position amounts to 1.7% of his total portfolio yield. If the return on cash falls to nothing, the total income from the portfolio falls from $58,000 to $57,000. It’s not a big deal.

What about someone without $1 million?

Let’s look at a different portfolio. Say this one is worth $50,000 with $10,000 in cash. We assume the same 6% return for the part of the portfolio at risk.

$50,000 @ 6% = $3,000 per year
$10,000 @ 2% = $200 per year

In this scenario somebody is forfeiting $200 per year–or approximately 6.66% of their total investment returns by not taking advantage of a high-interest savings account somewhere. That’s a bigger difference than before.

But at the same time, I’d argue that doesn’t really matter much either. If somebody makes $50,000 per year in employment income, $3,000 per year from their investments, and $200 per year from a high-yield savings account, the $200 per year just isn’t that important. Sure, it helps, but it helps a whole lot less than getting a raise at work, renting out a spare bedroom for cash, or going from a two car family to only having one car.

A disproportionate amount of attention

I’m not saying to immediately take your cash out of Tangerine’s pockets and keep it under your mattress. You might as well take advantage of high-interest savings accounts. Having $200 is better than not having $200.

But at the same time, we need to think more logically about the interest rates our savings get. The difference between 2% and 1.5% on $10,000 is $50 per year. On $1,000, it’s $5 per year. In other words, about the price of some overpriced beverage.

We get very excited about the chance to earn a few extra dollars in interest, yet don’t blink an eye about spending $100 extra on vacation or $500 extra on a car or whatever other big expense you might have. These are the things that truly matter.

Or, to quote myself on Twitter that one time: “The difference between 1% and 1.5% isn’t keeping you down. It’s keeping nobody down.”

1 Comment

With a long enough time horizon, a proper risk tolerance, and some savvy investing, you’re much better off to purchase high-quality, dividend-paying stocks than invest in interest-bearing savings accounts.